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9Questions is our Q&A series featuring key decision-makers in the corporate credit markets — get in touch if you know who we should be talking to!

In his capacity as co-lead portfolio manager for Invesco's US CLO franchise, Ian Gilbertson oversees the creation and management of CLO vehicles, as well as investing in and trading CLO securities managed by third parties.

He spoke to 9fin about current dynamics in the CLO market, including recent reset deals and the growing number of vehicles exiting reinvestment. He also touched on risks and opportunities within the secondary market in this uncertain economic environment.

1. What is the impact of more CLOs existing their reinvestment periods on the primary loan market?

If CLO refinancing activity does not pick up for older vintage transactions, approximately 40% of the US CLO universe could exit reinvestment period by the end of the year. 

This will affect how the broader leveraged loan market operates, as loan issuance — particularly amend-to-extend transactions — will need to be cognizant of the greater proportion out of reinvestment deals and their restrictions. 

CLOs are required to abide by a series of tests and criteria, one of which is a weighted average life (WAL) test. For many deals, if the CLO is failing its WAL test, it will be more difficult to participate in these loan extensions and the market will need to find an alternative solution.

2. How does that impact people who invest in CLO tranches?

The simplest answer is that it should create opportunities. CLOs are different from other structured products in that each CLO indenture is fairly unique. CLO investors are going to be rewarded for spending time understanding specific indenture terms and the flexibility it provides to the collateral manager during the post-reinvestment period. 

This is relevant for triple-A investments all the way down to equity. The pace of triple-A amortization will be affected by how aggressively a collateral manager is able to reinvest unscheduled principal payments and credit-risk sales. This, in turn, affects the leverage of a CLO, the size of equity distributions, and the timing of the CLO getting called.

3. CLO resets seem to be gaining popularity. How is that affecting market dynamics?

We saw a handful of CLO reset transactions price in July 2023, but these transactions almost entirely included elevated WACC structures from summer of 2022 which have just exited the call protection period. 

While the current tier one triple-A pricing range of ~SOFR+170bps does not appear attractive for resetting May CLOs, several deals that priced in 2022 with triple-A liability spreads north of 200bps are candidates to lower the cost of funding through a reset transaction. This is a minor part of the overall market, and will not materially impact the number of deals exiting reinvestment period by the end of the year. 

We estimate are there are 20-30 CLOs that could be potential candidates for this type of reset representing ~$10bn-15bn in potential reset volume for 2H23.

4. Are you seeing more opportunities in the secondary market?

The market has provided additional opportunities, with uncertainty and weakening credit fundamentals causing market price volatility. However, with every opportunity to buy loans at a discount, we are equally interested to reduce risk in other pockets identified by our deep credit team. 

Building par has been difficult in recent months, as loan prepayment rates have decelerated and many of the names we see as oversold become swap candidates for other names we are looking to sell at a discount. In addition, developing high conviction in a stressed situation is difficult as the rise in liability management exercises (LME) transactions makes predicting the potential path to recovery less certain.

Persistent downgrades by the public rating agencies, particularly into triple-C territory, make it even more difficult to purchase distressed opportunities as we see it most prudent to reserve triple-C capacity for future downgrades rather than utilize those buckets for a potentially oversold par-building opportunity.

5. How are you adjusting your portfolio amid the uncertainty surrounding interest rates, inflation, and the threat of a recession?

For better or worse, the risks associated with inflation and elevated interest rates have been apparent for several months now and are not new risks to the portfolios. 

Invesco has been steadfastly focused on these risks dating back to 2021, when we rotated out of low single-B names with high inflation risk and moved portfolios up in quality. That does not mean we are done de-risking, but the analysis is more idiosyncratic than just identifying borrowers who would suffer in a high interest rate environment. 

Elevated interest rates on overleveraged capital structures reduce the margin of error companies have to execute. Companies that are more likely to default this cycle will likely suffer from secular trends like cable cord-cutting, technological displacement like artificial intelligence tools, or plain and simple mismanagement and mis-execution. 

Complicating this analysis, there does not appear to be a specific sector or industry where defaults could be concentrated. Overleveraged capital structures are industry-agnostic. The key to differentiating our bull case from our bear case for defaults this cycle with be dependent on financial sponsor behavior: do PE sponsors support business with short term liquidity issues via equity capital infusions, or do they walk away and leave the keys to lenders?

6. How do you believe CLOs can improve their ESG commitments, and what steps do you see as the next logical progression in this area?

ESG adoption is pressured by a barrier to data transparency. To be clear, ESG data transparency within the broadly syndicated loan market has improved considerably over the past decade, but it is still a far cry from the information available to publicly traded companies. 

The market could benefit from further data transparency to help investors come to their own conclusions as to what the relative ESG risk is for a particular company. But it is not always clear what information is necessary to make that decision. 

The continued push for transparency of relevant ESG information will help CLO managers more easily commit to incorporating ESG risk assessment into their credit process. Support from financial sponsors, the LSTA, and the investment banking community will also be critical to further improvement within the space.

7. How do you measure the performance of an ESG CLO compared to a traditional CLO?

To date, we have not used different parameters to measure the performance of our ESG CLOs from our legacy CLOs. Both portfolios begin with a construction based on the proven Invesco credit process.

8. What are your views on competition between private credit and the broadly syndicated market, especially in light of the growth of private credit CLOs?

Private credit and broadly syndicated loan market have been in competition for decades. With that said, recent growth in direct lending has fueled a near-term shift in the pendulum toward private credit gaining modest market share in recent M&A activity. 

The private credit CLO market has more than tripled since 2017 to over $100bn currently. Private credit has also moved into the large-cap space and the size of direct lending solutions has increased in recent years. 

But it’s important to note that private credit CLOs are not in competition with broadly syndicated CLOs, and largely own separate collateral entirely. Private credit CLOs are merely a financing option provided to private credit originators, who are typically issuing loans to smaller companies. Overall, both BSL and private credit CLO markets have room for growth.

9. Can you tell us about a favorite book, person or idea that influences your investment decision?

The guiding principle to Invesco’s CLO management strategy has been risk management through the cycle. Our platform seeks to identify credit risk, quantify it using proprietary analytics, and construct portfolios that can deliver superior returns for our stakeholders under all market conditions. 

The idea that grounds this investment strategy is a base of discipline. When credit spreads are very tight, and the market appears at its peak, Invesco’s credit process echoes restraint and outlines a strategy that does not reach for yield. When the market is dislocated due to fundamental or technical pressures, the credit process also allows for logical evaluation and pricing of risk to deliver performance.

9Questions — Ian Gilbertson, Invesco — Tricky times for CLOs

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